Response to "Dealing Justly with Debt"

The following was received in response to our Inprint January/February cover story, “Dealing Justly with Debt.”The following was received in response to our January/February cover story, “Dealing Justly with Debt.”

The IMF may sometimes prescribe the wrong medicine to countries experiencing a financial crisis. Right now, the IMF’s support for the Lula government in Brazil is looking pretty good. By contrast, the medicine Mr. Barry proposes to cure Brazil’s debt problem looks more like snake oil. An “independent debt arbitration panel” is unlikely to “help countries escape and avoid financial crises”; on the contrary, it is more likely to precipitate and aggravate such crises. Consider these points:

In the absence of aid donors willing to supply unlimited financing, the only way for a country to avoid or overcome a financial crisis is by changing the policies, laws, and institutions that are causing domestic and foreign investors alike to lose confidence.

An arbitration panel with the power to force such changes would intrude on the sovereignty of countries far beyond what the IMF can do. Moreover, a panel that has the power to force write-offs on creditors before the point of default would discourage private capital flows to all emerging market economies.

Brazil’s public-sector debt has indeed grown too rapidly. A sustainable situation can be achieved either by reducing this debt or increasing the country’s capacity to meet interest and principal payments on it.

The route consistent with rising living standards is to raise the country’s debt-servicing capacity through rapid private-sector led growth. The Lula government should be applauded for taking this route.

The alternative of reducing the debt through international arbitration would lead to falling living standards, because few foreign investors would commit new financing to Brazil before the arbitration process concluded. Worse, simply announcing the intention to arbitrate would prompt Brazilians and foreigners to take their money out and invest it elsewhere.

The IMF has been trying for a year to design a weak version of an arbitration panel called the “sovereign debt restructuring mechanism.” The complexities are mind-boggling, and credible experts have labeled it fundamentally flawed.

To sum up, a country with foreign debt is like a family with a mortgage on its house. Who suffers when payments stop? Rarely is it the bank. Countries do not have the option of “selling the house” and moving into less costly accommodations. But they do have the option of cutting wasteful expenditures, eliminating subsidies to vested interests, and removing barriers to economic growth. That is not an easy approach, but it’s a smart one.